Broken Velocity: Yellen’s Low Inflation Quandary (Hint: FHFA Home Price Index Growing At 6.62% YoY)

Here is a brief summary of Fed Chair Janet Yellen’s thoughts from yesterday courtesy of Deutsche Bank’s Peter Hooper: The Fed is on track to raise rates once more this year and three times in 2018. Yellen recognized that inflation has been running low recently, and that while there was some uncertainty around this performance, one-off factors that are not expected to persist, and which have not been associated with the performance of the broader economy, have been important. At the same time, Yellen noted that monetary policy operates with a lag and that labor market tightness will eventually push inflation up.

Inflation has been running low “recently”? Actually, “inflation” (defined as core personal consumption expenditure price growth YoY) has been below 2% since April 2012 and below 3% since July 1992. Notice that hourly wage growth for production and nonsupervisory employees has remained low as well, particularly since 2007.

Of course, home price increases have been far greater than the “inflation” rate used by The Fed. The recent FHFA Purchase-only home price index YoY (released this morning for June) has US home prices growing at 6.62% YoY while “inflation” is growing at a palty 1.40% YoY.

But nothing really seems to be working as expected by some. Expanding the M2 Money Supply was supposed to increase Real GDP, but that really hasn’t worked since the Reagan/Clinton recovery when M2 Money Supply growth dropped from over 12.5% YoY in 1983 to 0.1% YoY in April 1995 under President Clinton and Federal Reserve Chair Alan “Maestro” Greenspan. Robert Rubin was the Treasury Secretary.

Notice that M2 Money growth has almost always been higher than real GDP growth since 1995. Hence, M2 Money Velocity has mostly been declining since 1997.

What about the old model where additional Federal debt is okay as long as real GDP growth is greater than Federal debt growth? We are nearly at that point again after decades of rapid Federal debt growth with modest real GDP growth.

I am guessing that rather than raise rates next year, The Fed may be forced to expand their balance sheet … again. Giving more oxygen to the asset bubbles.


As many Americans are forced to switch from exotic beers like Heineken to less expensive beers like Pabst Blue Ribbon.